Since 1990, Smart Bank has extensively loaned money to foreign businesses. During the Asian Financial crisis, a

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Question:

Since 1990, Smart Bank has extensively loaned money to foreign businesses. During the Asian Financial crisis, a SouthKorean customer defaulted on his U.S dollar denoted loan $5 million from smart bank with an interest of 12%.

During negations for loan restructuring, Smart Bank suggested that it would roll over the loan for another year, if the customer will grant smart bank the choice of payment between $5 million and $6.5 million won for principal when the loan matures. (The won payment was arrived at by multiplying the principal amount of $5 million with the prevailing exchange rate of 1,300 per U.S dollar).

a. Suppose the currency rate has an equal probability to depreciate to won 1,700 per U.S dollar or appreciate to won1,300 per U.S dollar. What is the value of the option to smart bank, assuming the interest cost for the bank loan of10%?b. What will be the value of an option of 12% interest of the bank?c. If the probability is 80% for the currency rate of won 1,300 per U.S dollar. What will be the new value of the option of 10% interest rate of the bank?